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In 2005, VWIF was confronted with a problem: out of the blue, the IFRS Board introduced higher demands on the calculation and documentation of financial hedging instruments, which had to be adopted at short notice. VW Head Office communicated this urgent requirement to its subsidiaries. Our objective at VWIF was to implement hedge accounting by year end.

Hana Meijer

Manager, Treasury & Back Office

René Ramos

Head of Accounting

Based in Amsterdam, the role of Volkswagen International Finance NV (‘VWIF’) is to finance Volkswagen’s corporate operations using a range of funding actions in the international capital markets. VWIF performs extensive inter-company lending/borrowing operations to execute funding distribution to the various VW companies. All funding positions are fair value hedged, via interest rate swaps and cross-currency interest rate swaps.

Problem…

“Many will recall the lack of clarity that accompanied the early days of the announcement of IAS39. The IFRS Board issued a series of high level directives but these lacked practical detail on how to implement a solution. Compliance requirements involved an innovative combination of accounting and risk management, posing new problems for treasury accountants and treasury technologists. The earlier implementation of FAS133 in the United States was not totally helpful, as there were material differences between FAS133 and IAS39 compliance.

“At VWIF, we naturally turned to the accounting profession for advice and guidance, but some of the advice we received was ambiguous and quite confusing. Members of our treasury peer group reported a similar situation. Opinions varied dramatically between audit firms over what were, or were not, IAS39 compliant hedge accounting solutions – even between different branches of the same audit firm! The situation was very fluid, as opinion evolved – and sometimes entirely changed direction.

“Our own compliance issues were compounded in several ways. The dollar offset method used to assess hedge effectiveness would not work at VWIF as this method, as is now well known, falls short when there is a small deviation in fair value between exposures and their hedges – the results are mathematically amplified to produce non-compliance. At VWIF, we needed to implement regression analysis to achieve IAS39 compliance. A further complication for us was our heavy use of cross-currency interest rate swaps. The issue here was the accurate translation of change in fair value in one currency into the correct spread for another.

“Our mission at VWIF was to complete a very demanding and visible project in a very tight timeline. Fourteen VW companies decided to use the hedge accounting reporting service that we were developing.”

…Solved

“After analysing various systems in use at VW, we chose IT2 to deliver the hedge accounting solution. We had been using IT2 for cash and treasury management for many years. In practice, we found that the technology companies were confronted with the same issues of interpretation as we were and they needed to deliver generic solutions to satisfy a range of requirement details as demanded by their client base. It was very hard work for all of us, with IT2 product management, development and professional services all involved, and having to cope with requirement changes on the way. IT2 provided a working regression solution, which fulfilled our central requirement. The solution went live in the first week of December 2005.

“In outline, the exposures are sent to VWIF from the central SAP system. IT2 derives the results, which are either sent to Sun Accounts for VWIF, or are reported to the companies. IT2 performs and reports on hedge effectiveness both retrospectively and prospectively as required. Our management reporting is simple: we use an IT2 report to show that our hedge relationships are all compliant. The purpose of this exercise is simply to provide transparent proof that hedge accounting is properly and effectively implemented at VWIF. An additional benefit is control over credit exposures, so that Volkswagen’s corporate credit policy is seen to be properly applied.

“In retrospect, things might have been easier if we had declined to proceed with the project until we were confident that we had a clear and stable specification, but perhaps we would have missed our deadline if we had adopted this approach. We are now in the rather unexpected position of being providers of a hedge accounting solution to 14 demanding clients, rather than just being users of IT2.

“The situation – at least with IAS39 compliance – is now quiet, and hedge accounting has settled in as a background process in our operations. We hope that will remain the case, but who knows what the IFRS Board might rule in the future?”